If you have a poor credit score, the impact on your finances can be substantial. Your options to obtain credit and pay a reasonable interest rate are very limited. Many people with poor credit cannot obtain a loan at all. Fortunately, there are steps you can take to improve your credit rating.
One of those steps is to borrow more money.
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Now, that doesn’t make sense on the surface. Many individuals developed a poor credit rating precisely because they borrowed more money. But just as borrowing (and messing things up) hurts your credit score, taking out a loan and paying it back as planned improves your credit rating.
The difference-maker is creating a budget for the loan payment.
Making a plan
If you need to borrow money for some reason, you need to create a plan. If you don’t create a budget each month, here’s a great opportunity to start the process. Your budget will give you confidence that you can make that monthly loan payment.
Writing down your budget
To budget, start with your monthly income. For most people, that’s your after-tax paycheck. Write that amount down on a piece of paper. Your expenses can be categorized into three "buckets" of spending:
- Fixed expenses: Amounts are the same each month, such as your lease or mortgage payment on a home, or your car insurance premiums. Say, for example, that you monthly after-tax income is $5,000 and that your monthly fixed expenses total $3,000.
- Variable expenses: Variable expenses include your utility bills and gas for your car.
- Discretionary spending: This is the spending that you control the most. The category includes include food and entertainment- and that coffee that you buy each morning
Once you fill in your fixed and variable costs, you need to make sure that your loan repayment amount can fit in your budget. Fortunately, there are some great apps you can use to compute the loan amount.
Budgeting your loan payment
Assume that you need to borrow $5,000 for a home repair. You are able to find a 8% loan for 3 years. Your loan will likely include amortization. Amortization means that each of your loan payments includes some repayment of the original amount borrowed (your principal).
Bankrate provides a website you can use to figure out your monthly payments for the $5,000 repair loan. In this case, the monthly payment is $157 (rounded), according to the website tool. Make sure that the $157 can fit into the budget you’ve created.
Working on your credit rating
You can use a loan to improve their credit rating. Your credit rating is calculated, in part, based on the timely repayment of principal and interest.
If the loan amount fits into your budget, you won’t have trouble making the payment. This borrowing activity will improve your credit score. A good credit rating will help your borrow at reasonable interest rates in the future.
The idea here is to borrow, repay- then borrow again as needed. Check your credit report periodically to make sure that your good credit activity is corrected stated on your credit history.
Over time, you’ll gain the satisfaction of building a great credit rating.
What other tools have you heard about to improve your credit score? I'd love to hear from you.
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